Waiting For Hormel To Get Cheaper Isn't Getting Any Easier

Once in a while even the best-loved food and beverage companies will sell off on concerns about organic growth trends or margin worries. So far, though, it looks like Hormel (NYSE:HRL) is largely immune, as although margins came up a little light this quarter, the Street seems willing to look past one quarter and remain focused on the attractive, higher-margin business management is building.

No Great Surprises In Fiscal Q3
Hormel didn't really offer many positive surprises for the fiscal third quarter, though I wouldn't say it was a bad quarter either.

Revenue rose more than 7% as reported, basically spot on with Street expectations. While Grocery sales would have been flat if not for the inclusion of Skippy, Refrigerated rose 2%, Jennie-O rose 4%, Specialty rose 5%, and International/Other rose 31%. All told, Hormel saw volumes improve 3% in the quarter – not bad at all relative to both packaged food peers like Kraft (Nasdaq:KRFT) and protein companies like Tyson Foods (NYSE:TSN).

Margins weren't as positive. Gross margin was flat with the year-ago level, and about a point below expectations. Higher pork prices hurt results in the Refrigerated business, even though Hormel is usually able to pass along higher costs pretty quickly. Segment operating income rose a little more than 5% (and overall operating income rose about 5%), as the company saw costs tied to the Skippy deal and lower affiliate earnings.

M&A Coming, But Maybe Not Where The Street Is Looking
Hormel has been relatively candid about its intentions to continue growing the business through M&A as circumstances allow. Curiously, though, even though management has offered more detail than the typical “no comment” from most companies, the Street doesn't want to listen.

Management has doubled its debt threshold to about $2 billion to fund deals, but continues to talk about doing additional Skippy-like deals. Even so, analysts continue to speculate on moves for Hillshire Brands (NYSE:HSH) (enterprise value of $4.6 billion) and Maple Leaf IFoods (enterprise value of about $3.1 billion). While I can see the strategic argument for Hillshire (less so for Maple Leaf), I would think management would like to find additional easily-digestible deals like Skippy, particularly if they also offer upside from better execution and product development. With Unilever (NYSE:UL) selling off its food operations in pieces and both Kraft and Nestle (Nasdaq:NSRGY) possibly considering some product restructurings, I don't think Hormel will lack for candidates.

Meanwhile...
Whether or not Hormel does another major deal in the near future, there's a lot to like about this business. Management continues to execute a strategy that sees the company moving away from the more commodity-driven protein businesses and towards the more predictable packaged foods categories. Recent product introductions like wraps, dips, turkey franks, and breakfast burritos are a good example of both the ongoing product innovation and management's desire to “double dip” and make better use of its existing protein operations.

The Bottom Line
I continue to like everything about Hormel except the price of the stock. Part of my reticence to buy Hormel is due to the fact that I already own the shares of a similar story in Brazil (Brasil Foods (Nasdaq:BRFS). They're not identical (Brasil Foods is much more of a commodity protein producer today than Hormel), but they're similar with respect to both managements explicitly targeting further growth in packaged branded foods and overseas growth (China for Hormel, the U.S. and Asia for Brasil Foods).

In any case, 6% long-term revenue growth and 13% free cash flow growth estimates only get me to about $44 on Hormel shares, and that's not much margin of safety relative to today's price. While I am concerned that being too conservative and value-obsessed with Hormel will keep me on the outside looking in, I'd still prefer to wait for a pullback before adding these shares to my own account.

Disclosure – At the time of writing, the author owned shares of Brasil Foods.